Newsletter

Our economic times: A fraudulence for the ages

The myriad cases of fraud and corruption in the finance and banking industry over the last two decades have been truly staggering.

It is clear that left to their own devices, major players in the industry seek profit at the expense of innocent customers, effectively hiding behind the veil of the corporation. This type of egregious behavior tugs at the moral fiber of the industry, severely compromising any integrity left on Wall Street.

From the onset of his July 17 semi-annual speech to the U.S. Senate Banking and Finance Committee, Ben Bernanke, chairman of the Federal Reserve, was peppered with questions surrounding the manipulation of a key interest rate tied to hundreds of trillions of dollars in loans by a major international bank to its own gain.

This is just the most recent case of a disturbing, but not surprising, breach of public trust once again by the banking industry.

Barclays Bank in the United Kingdom has been charged with fixing the LIBOR interest rate during various periods since late 2004 and has been fined $500 million.

LIBOR, or the London Interbank Offered Rate, is a key benchmark used to measure the rate at which banks borrow from one another. This rate serves as a reference for upwards to $300 trillion in mortgage and other consumer loans.

Though Barclays Bank is taking the most heat for the scandal, other banks are suspected to have been involved.

The LIBOR rate is ultimately determined by the British Bankers Association (BBA), but its calculation is dependent on information provided by numerous major banks around the world. Here is the central problem: The numbers big banks report to the BBA are not based on observable transactions or data. They are given as good faith estimates.

Really?

A bank may rig their reported interbank rates for two reasons.

First, a bank may choose to under report their borrowing rates to convey a signal of good financial health. This type of rate fixing to avert higher borrowing costs was pervasive during the 2008 crisis when most large banks were financially compromised and unwilling to lend to other banks.

The second motivation to manipulate the LIBOR rate lies in the direct capital gains of the investment banks themselves. Banks under or over reported the interbank rates to capitalize on large open positions in the market such as those in pension and mutual funds whose value may wax or wane with movements in the LIBOR rate.

The scope and scale of the scandal has yet to unfold entirely, but there is good reason to believe several U.S. banks were involved. JP Morgan Chase, Bank of America and Citigroup are among U.S. banks that provide information to the BBA and contribute to the LIBOR rate calculation.

Still, there remains something eerie and unsettling about this crime unlike others in the past.

The LIBOR rate is inextricably tied to millions of households. It underpins a family’s monthly bills and budget through mortgage, auto and student loans, and it influences the value of pension and mutual funds, the primary source of retirement income and household wealth for millions.

At a time when many in the U.S. are calamitous over our nation’s debt, a violation of household trust in our banking system of this magnitude warrants vehement consequence.

But what about the regulators? What about Dodd-Frank?

In his testimony, Bernanke defended the Fed’s position, claiming once they were made aware of the fraud they notified the appropriate regulators, doing little to directly mitigate, address or alleviate the issue or impending ripple effects sure to follow.

However, the Fed knew about this as early as April 2008. And though the scandal is primarily housed in the UK, the degree of international financial integration justifies a global view of industry checks and balances.

Have we really come to a crossroads where the regulators need to be regulated?

The culprits and supervisors of the system will most likely go through the same slap-on-the-wrist promenade as usual, letting the corporation’s owners (shareholders) pay their penalties. The system really is that defunct and until the consequences actually fit the crimes, it will be business as usual for Wall Street at the expense of Main Street.

Dr. Nicholas J. Mangee is an assistant professor of economics at Armstrong Atlantic State University and may be reached at Nicholas.mangee@armstrong.edu.